Dominic Alexander explains why the Bank of England’s response to inflation will be disastrous, particularly for working people

The Bank of England raised interest rates by 0.25% this Thursday (6/5/22), following the US equivalent, the Federal Reserve’s even more aggressive 0.5% hike the previous day. The argument is that this is necessary in order to control the rapid rise in inflation. The Bank of England warns that the change ‘will take time to work’, admitting that in the immediate term ‘inflation will keep rising this year’.

In other words, things will get worse before they get better, on the assumption that this policy will work at all even in the long run. In the shorter term, it will make borrowing more expensive, with an impact both on households with debt, and on business investment. The risk is that this will push the economy into recession, but even if, technically, that point is not reached, the whole aim is to slow the economy. This means less expansion, and so more unemployment, and downward pressure on wages. It will not mean curbing the bumper profits of energy companies. Indeed, the point is to protect capitalist assets against the pressure of inflation, which is seen as the greater danger than recession.

This is at a time when prices of the basics, food and energy, are rising catastrophically, and many are already facing desperate circumstances, but, as always in a capitalist economy, the orthodoxy is that living standards must take the hit, if the crisis is to be fixed. The explanations we’re given in this instance are that inflation is the result either of demand outstripping supply (Keynesianism), or that money has become too cheap, due to excessive government spending (Monetarism). Neither theory is an adequate explanation of what is happening now.

It should be evident to all that it is supply problems, due to energy-price rises, logistical disruptions, and now the war in Ukraine, that are currently fuelling inflation. Raising interest rates will not alleviate any of these factors. So why is it being touted as the answer? At one level, the reason lies in the limitations of mainstream economic theory.

Orthodox explanations of inflation

Central bankers’ monetary policy has been singularly ineffective in recent years. After the 2008 crash, ever greater interest-rate cuts, and money creation (‘quantitative easing’) were meant to make investment cheaper, and therefore encourage growth. This did not happen, with companies preferring to hoard capital rather than risk it in a situation where returns seemed likely to be low. This policy invited the derisive epithet that it was ‘pushing on a piece of string’, because the action was having little or no impact on its object. However, it was not without effects, because it did fuel the asset boom: rising stock-market prices, property prices and so on. It is just that these rises were speculative rather than driving any economic growth which would raise profitability. Underlying the growth of all that fictitious capital was economic stagnation.

Before the pandemic forced extraordinary support measures, the economic indications were that the global economy was once again heading towards outright recession, rather than simply low growth. Measures to prevent collapse during lockdowns, inadequate as they were, did stave off that prospect, but since governments have been withdrawing those supports, the system began to lurch into a new crisis.

For mainstream Keynesians, the present inflationary problem is the result of ‘pent-up’ demand due to covid. This is the standard theory that inflation is caused by excess demand, and that suppressing demand (reducing wages and the standard of living), will reign in inflation, and fix the problem. For the monetarists, it was excessive government spending that was the problem, but that amounts to the same effect: raise interest rates to shrink the economy, in order that it will re-balance.

Notice that orthodox economics, whichever its hue, always comes up with the same answer. In ‘normal’ circumstances, if an economy is growing, the danger is that inflation will jump forward, so to restrain it, demand must be contained. Therefore wages and living standards must be prevented from rising. In the converse situation, when the economy is contracting, then it is wise to take action which will encourage inflation, to make investment cheaper. This can only work so long as wage rises don’t eat up the space those poor, hard-pressed capitalists have for expansion. Since capitalism is always in a cycle of rising or falling growth, there is never a time when orthodoxy won’t decry the danger of wages being too high.

The judgement of history

That is just reality, and there is no alternative, orthodoxy will sternly reply. Yet, do mainstream explanations of inflation actually stand up? They do not, and history has already demonstrated this. In the ‘stagflation’ of the 1970s, a situation that was supposed to be impossible occurred; a period of low growth was accompanied by dramatically rising inflation. Keynesian demand-management failed, and monetarism arrived as an alternative, instituting the series of attacks on workers and the welfare state that we call ‘neoliberalism’. However, monetarism never adequately explained the situation in the 1970s, any more than it does now. It simply mobilised the political and economic forces of capital to engage in a class war that reduced the power of labour to fight for a better share of the social surplus.

To a strictly limited degree, neoliberalism succeeded in raising the rate of profit in western economies, but that policy ran out of road in 2008. Profit rates have not recovered since then, and so investment has been stagnant. The supply problems we face now are partly due to the disruption of the pandemic, as well as the war in Ukraine, but they will not be a short-lived issue that can be fixed with central banks’ tinkering with interest-rates policy. If profitability is low, then capitalists won’t invest in expanding production, and so we have multiple sources of supply problems.

As Michael Roberts has argued, the deeper problem is low profitability, which preceded the current crises, and likely means that we face another period of ‘stagflation’, which won’t respond to the orthodox recipes of interest-rate manipulation, any more than the economy did in the 1970s, or in the period after the 2008 crash. However, the capitalist answer to low profitability is always to attack the living standards of labour, so despite all the evident holes in the orthodox approach, the current Bank of England policy will still convince most, at least, of the ruling class.

A dissident note will be struck by some on the Keynesian left, such as Larry Elliott in The Guardian, who warns that the rate rise risks causing a recession. He clearly perceives the inadequacy of the standard approach: ‘it is hard to envisage the government watching the economy slide into recession without doing something to alleviate the pain. The Bank has upped the pressure on Rishi Sunak to act – and act big.’ Elliott’s implication is that the bankers know their policy won’t work, and that government intervention is needed.

Elliott leaves it there, but the precise nature of government intervention is what remains crucial. The credit creation of the post-2008 years did nothing for the wider economy, only feeding the stock market and larger capitals. What is needed is action which escapes from the miserable logic of capitalist profit-seeking. The entire energy sector needs to be nationalised, and its profits redistributed into lower prices, and sustainable alternatives. That would be one immediately useful step, and isn’t even impossibly radical, given that the French, for example, have a state controlled energy sector.

However, that alone would not be nearly enough to deal with the present crisis. There needs to be a wide and massive state programme to build sustainable infrastructure around not just energy, but food, transport, housing and other sectors. All of this could physically be done, however much it would outrage capital. Yet, if the capitalist system cannot supply the necessities we need to live, then another path needs to be taken.